Transparency of Liabilities a Growing Trend

Since December 2010, companies like Honeywell, AT&T,
Verizon Communications and UPS announced mark-to-market recognition in the
corporate earnings statement of pension gains and losses, creating a more
transparent representation of the economic cost of the pension plan in their
income statements by marking to market their funded status immediately without
smoothing. The U.S. Financial Accounting Standard Board (FASB) requires
employers to recognize the full value of their funded status on balance sheets,
with a deficit shown as a liability. The “new FAS 87” method increases the
P&L cost immediately whereas “traditional FAS 87” increases P&L cost
gradually through amortization.

These four corporations’ moves to mark-to-market accounting
coincided with the International Financial Reporting Standards (IFRS), an
initiative that simplifies the way pension income or loss is recognized by
publicly traded companies outside the United States.

Because it is in most companies’ interests to have a
consistent approach to accounting, it seems that mark-to-market accounting will
reach a tipping point, said Bob Collie, chief research strategist for Americas
Institutional, Russell Investments, in research about the $20 billion
club—Russell’s name for the 19 U.S. listed corporations with worldwide defined
benefit pension liabilities in excess of $20 billion. If other companies follow
suit, analysts will come to expect mark-to-market figures, he said.

“I don’t think it would take much for the trend to
continue,” Collie told PLANSPONSOR,
adding that the change in international accounting standards could prompt the
U.S. to converge with this method.

However, some companies are hesitant to adopt mark-to-market
accounting because of volatility, Collie added.

One of the biggest advantages of mark-to-market accounting
is transparency, said Karin Franceries, executive director of J.P. Morgan’s
Asset Management Strategy Group. “The simplification of accounting makes the
link between the pension fund and plan sponsor clearer,” she added.

The Impact of Accounting on
Asset Allocation

Accounting methods also have a direct impact on asset allocation. By
using mark-to-market, it is easier to derive the impact of a company’s asset
allocation because it is immediately translated in its pension cost, Franceries
said.

Under the new FAS 87 accounting method, the expected return
on assets is not reflected in the annual report. Without smoothing, the full
impact of the deficit will show up on a company’s books immediately in the year
it occurred. A higher deficit increase triggered by a riskier allocation would
result directly in a greater loss, according to J.P. Morgan’s research paper,
“The mark to market treadmill.”

Because reporting under the new FAS 87 method mirrors what
is actually happening to a pension fund, it allows a CFO to focus on the
economic reality of funded status. Investment solutions that stabilize pension
costs on the income statement under the new FAS 87 approach will be similar to
those that stabilize liabilities on the balance sheet, the paper said.

J.P. Morgan’s paper provides a real-life case study showing
what affect asset allocation would have on pension reporting. The paper can be accessed here.

Russell Investments’ research paper, “A busy pension year so
far for the $20 billion club,” is available here.